Issues Facing the Japanese Economy in 2007

Prescription to Ease the Problem of Growing Inequality

Fellow, RIETI

Weak recovery and widening gap in wages

The Japanese economy has been on a recovery path since February 2002. Japan is said to now be experiencing the longest growth period since the end of the war, surpassing the 57-month-long "Izanagi boom" from 1965 to 1970. However, the ongoing growth, at an annual rate of 2.4%, is extremely feeble compared to the 11% growth of the Izanagi boom. The government had been expected to finally declare an end to deflation in mid-2006 but such an announcement now apparently will not come before the end of the current fiscal year.

The biggest problem is the weakness of recovery in household consumption and wages. About a year ago, many economists predicted that wages would begin to rise in mid-2006, leading to a strong recovery in consumption. But wages have been slow to respond in spite of the continuing strong performance of Japanese companies.

This seems to be attributable to structural changes in the corporate governance of Japanese companies as well as in the power relationships between labor and management. Amid the protracted slump that followed the bursting of the bubble economy, the number of non-regular workers began to rise rapidly in the late 1990s. Easing of restrictions on temporary staffing services was the major factor that prompted the changes. The deregulatory measure, however, was imperative at the time as Japanese companies were ailing and, without a shift toward non-regular employment, many of them would have gone bankrupt. In this regard, such employment certainly mitigated the impact of the slumping economy. This, however, has brought structural changes to the power relationships between labor and management, weakening the bargaining power of workers.

Another important factor is that the "main bank system," a governance mechanism based on long-term relationships between banks and their corporate customers, collapsed under the combined impact of the post-bubble slump and acute financial crisis of the late 1990s. When banks refused to extend new credit and rushed to recall loans during that critical period, Japanese companies learned their lesson and their faith in their main bank as an anchor in bad times has subsequently been lost. In the meantime, the power of shareholders has been substantially strengthened, whereby companies are facing growing pressure to pay dividends. As a result of all these changes, corporate mangers are increasingly inclined to keep ample liquidity on hand, instead of increasing wages, which enables them to future finance capital investments or pay out dividends to shareholders. These structural changes are likely to have caused a significant delay in the much-expected wage increase which, under ordinary circumstances, would have taken place at this stage of the economic cycle.

From this scenario emerged the problem of growing inequality that last year drew considerable attention from critics and the media. Although there remain some disputes regarding data showing the state of inequality, awareness of inequality is obviously growing within Japanese society, engendering a major backlash against market-oriented structural reform.

The notion of attributing such inequality to intensifying market competition will lead to calls for a more active government role in correcting the inequality, namely by means of fiscal redistribution. The government is in fact, for fiscal consolidation, reducing social security expenditures in various areas. Consequently, some among the weak and vulnerable receive little medical and/or welfare assistance and their situations have become even worse, which has fueled public anger against inequality.

Arguing for the correction of inequality under government initiatives equates to a call for greater government expenditure. Conservative politicians would be eager to boost spending on public works projects, thereby benefiting local construction firms and contractors, as a means to alleviate economic disparities between urban and rural areas. However, this represents a return to old-fashioned pork-barrel politics.

Egalitarian-minded individuals are calling for increased financial support for programs and services designed to assist society's weak and vulnerable, such as medical and welfare programs as well as assistance for the unemployment. Unless targeted beneficiaries are limited to the truly weak and vulnerable, each of these prescriptions will inevitably call for a significant increase in government expenditure. And this would inevitably call for considerable tax increases, though many avoid this discussion.

Need to ensure enforcement of market rules

Recent years have witnessed a spate of business scandals, ranging from the Livedoor and Murakami Fund incidents which significantly impacted the financial markets, to quake-resistance data fabrication. The sum of these incidents suggests that the existing mechanism for ensuring compliance with rules, an essential prerequisite for fair market competition, has profound defects. Resent toward market competition grows because of those who get away with dirty gains; no one complains about those who make profits through fair competition. Therefore, one role the government can and should play is to create a market environment that facilitates fair competition. It is important to establish market rules and an efficient mechanism for subsequent monitoring of compliance with those rules.

Discrimination between regular and non-regular workers in wage and other benefits, symbolic of Japan's inequality problem, can be also viewed as stemming from inefficient market rules. In macroeconomic terms, Japanese workers are not necessarily unfairly underpaid. Indeed, labor's share of national income has recently tended downward but the absolute level is not far too low relative to those observed in the United States and Europe.

During the first half of the 1990s, immediately after the burst of the bubble, labor's share of national income continued to rise in Japan. In a sense, Japanese workers are now paying the bill for what they received in excess during the post-bubble years. Thus, it is not possible to draw the simple conclusion that labor's share should be increased by reducing capital's share.

Rather, the significant gap between privileged regular employees and unfairly exploited non-regular workers is suspected to be at the root of various maladies, including weak consumption. What needs to be addressed is not the problem of labor's excessively low share of national income. In order to solve the problem of employment inequality, it is important to ensure that fair and equitable rules - such as the principle of the same pay for the same job - are fully implemented and applied throughout the labor market. The type of policy needed to address this problem is not the redistribution of income by the government but the development of efficient rules for the labor market.

Who should take over community functions?

Cutbacks in social safety net programs can easily provoke a backlash against government efforts, not only toward fiscal consolidation but also toward structural reform in general. In order to achieve such long-term reform and fiscal consolidation, the government needs to devise ways to maintain public support for its reform initiatives, for instance securing generous expenditures on measures designed to help the poor and the medically disadvantaged. From the viewpoint of maintaining political support, it is important to develop fair and equitable market rules and to enhance the subsequent monitoring mechanism. Well-designed fiscal consolidation underpinned by a well-targeted safety net and an institutional environment in which all individuals can feel assured of the fairness of the market are needed.

The ongoing criticism of inequality has another hidden issue - the fact that the Japanese company has ceased to function as a community for its employees. In postwar Japanese society, companies emerged as quasi-communities that provide reliable support for workers amid the dwindling presence of traditional communities such as families and villages.

Japanese companies are - at least in image if not reality - perceived to be a community of workers anchored by the lifelong employment system and corporate welfare programs. Probably because of this perception, Japanese society has long been strongly averse to companies laying off employees. As mentioned, Japanese companies maintained employment and continued to increase labor's share of national income in the first half of the 1990s despite the increasing severity of the nation's economic slump. This, in part, stemmed from companies' recognition that ensuring job security is their social responsibility. From around the late 1990s, however, Japanese companies - having seen the prolonged economic slump continue to weigh heavily on their earnings - began to abandon their social roles as communities. Hence, the lifelong employment system began to crumble as more and more companies embarked on drastic restructuring measures such as reducing the number of those on the regular payroll and increasing non-regular workers.

Companies, which were counted on to take on a community role to give moral support to employees, betrayed such expectations by rushing to adopt a "profit-at-any-cost" approach. Anger at this about-face is what lies underneath the ongoing debate on inequality. There is also desire to restore communities within the Japanese society.

The question is not just one of financial disparities. One answer to this highly complex problem of inequality can be seen in the direction of policy under the administration of Prime Minister Shinzo Abe. Envisaged there is a society in which a strong national government serves as a community that provides a pillar of support for society while advocating economic liberalism. The message is quite coherent but this provokes concerns over the danger of falling into reactionary nationalism.

On the other hand, many egalitarian-minded individuals are stressing the importance of the government's redistribution function. However, when combined with people's anxiety and discontent heightened by the collapse of company-based communities, this argument would in fact serve to accelerate the recently-observed tendency toward nationalism. These critics should be conscious of this and be more prudent in expressing their ideas.

The natural course of events would be for communities to be restored spontaneously through private-sector efforts or market forces, not through some sort of government arrangement. Socio-economist Yosuke Mamiya warns that a market society, if left to evolve into a society where autonomous individuals independently participate in the market with communal organizations completely destroyed, could become something akin to a fascist society (Keynes and Hayek). Mamiya calls for reinforcing "intermediary entities" (civic groups, universities, cultural associations, trade associations, etc.) that exist between the state and autonomous individuals, which he says is essentially the only way to restore a desirable balance to the market economy.

Given the current state of affairs, Japan may have no other choice but to count on civic groups such as nonprofit organizations (NPOs) to lead the way toward restoring corporate welfare. Spontaneous private-sector efforts - with the help of appropriate government policy measures such as increasing tax incentives for donations and inducing corporate efforts to extend more support to working parents - will successfully restore communities in Japan. This, indeed, is a major challenge facing the Japanese economy.

January 5, 2007

January 30, 2007

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